Pricing Strategies

What is Price?• Price ğ the amount

of money charged for a product or service(narrowest sense)

• Price ğ the sum of all the values that consumers exchange for the benefits of having or using the product or service

• Major determinant of buyer choice

• Only element in the marketing mix to produce revenues

• Most flexible element of the mktg mix

Pricing Decisions• Pricing & price competition ğ imp. problem facing many

mktg managers• Common Pricing Mistakes:

• Companies too quick to reduce prices to get sales• Pricing too cost-oriented (not reflecting customer value)• Price not revised often enough to reflect market

changes• Price set without taking into account other

elements of the marketing mix• Price not varied enough for different products,

market segments and purchase occasions

Pricing Decisions and Strategies

• Several price-quality positions in a given market Segment Example

Ultimate Rolls-RoyceGold Standard Mercedes-BenzLuxury AudiSpecial needs VolvoMiddle RenaultEase/convenience Ford Escort Me too, but cheaper HyundaiPrice alone Kia

PriceHigh Medium Low

High

Low

Pro

du

ct Q

ual

ity

Med

1.Premium Value

1.Premium Value

5.Medium Value

9.Economy

4.Overcharging

7.Rip-Off8.False

Economy

2.High Value

3.SuperValue

6.Good-Value

Price - Quality Strategies

Setting the Pricing

1. Selecting the pricingobjective

2. Determining demand

3. Estimating costs

4. Analyzing competitors’costs, prices, and offers

5. Selecting a pricingmethod

6. Selecting final price

Marketing

Objectives

SurvivalLow prices to cover variable costs andsome fixed costs to stay in business.

Current Profit Maximization Choose the price that produces the maximum

current profit

Market Share LeadershipLow as possible prices to become

the market share leader.

Product Quality LeadershipHigh prices to cover higher

performance quality and R&D.

Selecting the Pricing Objective

Determining Demand

• Demand sets a ceiling on the price that the company can charge for its product

• Each price will lead to a different level of demand

• Demand and price are generally inversely related ğ the higher the price, the lower the price

• For prestige goods ğ consumers perceive the higher price as quality signal

• Pricing is affected also by consumer perceptions of price and value

Determining DemandPrice Sensitivity

• Customers are less price sensitive when:

• The product is more distinctive,• Buyers are less aware of substitutes,• Buyers can not easily compare the quality of

substitutes,• The expenditure is a minor part of buyer’s total

income,• The product is perceived as having more quality,

prestige, or exclusiveness,• Buyers can not store the product

Determining DemandPrice Elasticity

• Marketers need to know how responsive or elastic the demand would be to a change in price

Price Elasticity of Demand = % Change in Quantity Demanded

% Change in Price

• Demand Demand ğğ less elastic less elastic in case of; in case of;• few or no substitutes or competitorsfew or no substitutes or competitors• buyers do not notice the higher pricebuyers do not notice the higher price• buyers are slow to change their buying habitsbuyers are slow to change their buying habits• buyers think that higher prices are justifiedbuyers think that higher prices are justified

Price Elasticity of DemandPri

ce

Quantity Demanded per Period

A. Inelastic Demand - Demand Hardly Changes Witha Small Change in Price.

P2

P1

Q1Q2

Pri

ce

Quantity Demanded per Period

P’2

P’1

Q1Q2

B. Elastic Demand -Demand Changes Greatly Witha Small Change in Price.

Estimating Costs

• Costs set the floor on the price• The company wants to charge a price that covers all

its costs and provides a fair rate of return for its effort & risk

• Many companies work to become low-cost producers in their industries

• Management needs to know how its costs vary at different production levels (cost per unit)

Estimating Costs Types of Costs

Total CostsSum of the Fixed and Variable Costs for a Given

Level of Production

Total CostsSum of the Fixed and Variable Costs for a Given

Level of Production

Fixed Costs

Costs that don’tvary with sales or production levels.

(e.g. executive salaries, rent)

Fixed Costs

Costs that don’tvary with sales or production levels.

(e.g. executive salaries, rent)

Variable Costs

Costs that do varydirectly with the

level of production.

(e.g. raw materials)

Variable Costs

Costs that do varydirectly with the

level of production.

(e.g. raw materials)

Estimating Costs Costs Considerations

Cost

per

unit

12

3 4SRAC

LRAC

Quantity Produced per Day

1,0

00

2,0

00

3,0

00

4,0

00

Cost Per Unit at Different Levels of Production Per Period

Estimating CostsExperience Curve

• As the firm gains experience in production; • The experience curve (or the learning curve) ğ

average cost drops with accumulated production experience.

• Strategy ğ company lowers the prices sales increases costs continue to decrease and then lower prices further.

• Risks are present with this strategy: aggressive pricing may give the product a “cheap image”

• Assumption: the competitors are not fighting back

Estimating CostsDifferentiated Marketing Offers

Activity-based accountingğ used in estimating the real profitability when dealing with different customers

• To identify the real costs associated with serving each customer

• By identifying the true costs ğ the company is able to explain its charges to the customer

Target costing • Establish a new product’s

desired functions

• Determine the price at which the product will sell

• Price - desired profit margin = target cost

• Examine each cost element /• consider ways to reengineer

components, eliminate functions & bring down supplier costs

• The objective ğ to bring the final cost projections into the target cost range

Analyzing Competitors’ Costs, Prices & Offers

• Consider the closest competitor’s price• In case of offering additional differentiation

points; • their worth to the consumer should be evaluated

& added to the competitor’s price• Decide whether to charge more, the same, or

less than the competitor• Be aware that competitors can change their

prices in reaction to the price set by the firm

General Pricing Approaches The Three C’s Model for Price Setting

General Pricing Approaches

Cost-based pricing • Cost-plus pricing

• Adding a standard markup to the cost of the product

• Ignores demand and competition

• Popular pricing technique because:

• It simplifies the pricing process

• Price competition may be minimized

• It is perceived as more fair to both buyers and sellers

• Break-even pricing (target return pricing)

• Setting price to break-even on the cost of making and marketing products / or to make the target (desired) profit

• Break-even charts show total cost and total revenues at different levels of unit volume.

• The intersection of the total revenue and total cost curves is the break-even point.

• Companies wishing to make a profit must exceed the break-even unit volume.

Cost-Plus Pricing Example- Variable costs: $20 - Fixed costs: $ 500,000- Expected sales: 100,000 units - Desired Sales Markup: 20%

Variable Cost + Fixed Costs = Unit Cost

Unit Sales

$20 + $500,000 = $25 per unit

100,000

Unit Cost = Markup Price (1 – Desired Return on Sales)

$25 = $31.25 (1 - .20)

General Pricing Approaches

Break-Even Analysis and Target Profit Pricing

General Pricing Approaches

Fixed Cost

Total Cost

Total Revenue

Sales Volume in Units (thousands)

Thousands of Dollars

0 10 20 30 40

1000

800

600

400

200

Break-even point

Target Profit $200,000

Quantity To Be Sold To Meet Target Profit

General Pricing ApproachesValue-based Pricing

• Percieved-value pricing ğ Setting prices based on buyers’ perceptions of value, rather than on the seller’s cost.

• Measuring perceived value can be difficult.• The firm use the nonprice variables to build up perceived value in the

buyers’ minds ğ price is set to capture this perceived value

• Companies using this approach ğ must find out what value the buyer assigns to different competitive offers

• More and more marketers have adopted value pricing strategies ğ offering just the right combination of quality and good service at a fair price.

• Value pricing at the retail level ğ Everyday low pricing (EDLP) vs. high-low pricing (hi-lo)

ProductProduct

CostCost

PricePrice

ValueValue

CustomersCustomers

CustomerCustomer

ValueValue

PricePrice

CostCost

ProductProduct

Cost-Based Pricing Value-Based Pricing

Cost-Based vs. Value-Based Pricing

Example of Perceived Value to Set Prices

• Utility: The attribute that makes it capable of want satisfaction

• Value: The worth in terms of other products

• Price: The monetary medium of exchange.

Value Example: Caterpillar

Tractor is $100,000 vs. Market $90,000

$90,000 if equal 7,000 extra durable 6,000 reliability 5,000 service 2,000 warranty $110,000 in benefits -

$10,000 discount!

General Pricing Approaches Competition-based pricing

Going-rate pricing ğ prices are set based largely on following competitors’ prices rather than on company costs or demand.

• Firms feel that the going rate represents the collective wisdom of the industry

• They also feel that holding to the going-rate price will prevent harmful price wars.

Sealed-bid pricing The firm sets prices based on how the firm thinks competitors will price, rather than on its own costs or demand estimates

Auction-type pricingBecomes popular esp. with the growth of the Internet

Pricing Decisions and Relation with Marketing Mix Strategy

Price decisions must be coordinated with product design, distribution, and promotion decisions to form a consistent mktg program

Some companies make their pricing decisions first and base other mktg mix decisions on

Some others de-emphasize price and use other mktg mix tools to create nonprice positions

Pricing Strategies A company sets no single price, but ğ a pricing

structure that covers different items in its line

Pricing structure changes over time ğ as products move through their life cycles

The company adjusts prices ğ in order to reflect changes in costs and demand & to account for changes in buyers and situations

The company initiates price changes and respond to them ğ as the competitive environment changes

New Product Pricing Strategies

• Conditions:• A sufficient number of buyers must have a high current

demand• The product’s quality and image must support its high

price (high price should communicate a superior product)• The unit costs of producing a small volume cannot be so

high that they cancel the advantage of charging more• The high initial price should not attract more competitors

to the market

• Market Skimming ğ setting a high price for a new product to “skim” maximum revenue from the segments willing to pay the high price.

New Product Pricing Strategies (cont.)

• Conditions:• The market must be highly price sensitive and low price

produces more market growth• Production and distribution costs fall as sales volume

increases (result of accumulated production experience)

• The low price discourages actual and potential competition

• Market Penetration ğ setting a low price for a new product in order to attract a large number of buyers and a large market share

Product Mix Pricing

• Product Line Pricing • Optional-Product Pricing • Captive-Product Pricing• By-Product Pricing• Product Bundle Pricing

Product Mix Pricing

• Sellers use a well-established price points for the products in their line

• The seller’s major task is to establish perceived quality differences that support the price differences

1.) Product Line Pricing ğ setting the price steps between various products in a product line;• based on cost differences between the products,

customer evaluations of different features, and competitors’ prices.

Product Mix Pricing

2.) Optional Product Pricing ğ pricing optional or accessory products sold with the main product.

3.) Captive Product Pricing ğ setting a price for products that must be used along with a main product.

• Two-Part Pricing ğ in the case of services • the price of the service is broken into a fixed fee plus a

variable usage rate)

Product Mix Pricing (cont.)

5.) Product Bundle Pricing ğ combining several products and offering the bundle at a reduced price

4.) By-Product Pricing ğ setting a price for byproducts in order to make the main product’s price more competitive

Price Adjustment Strategies

• Discount and Allowance Pricing – reducing prices to reward customer responses such as paying early or promoting the product

• Segmented Pricing – adjusting prices to allow for differences in customers, products, or locations

• Psychological Pricing – adjusting prices for psychological effect

• Promotional Pricing – temporarily reducing prices to increase short-run sales

• Geographical Pricing – adjusting prices to account for the geographic location of customers

• International Pricing – adjusting prices for international markets

Price Adjustment Strategies (cont.)

• A cash discount ğ price reduction to buyers who pay their bills without delay

• A quantity discount ğ price reduction to buyers who buy in large volumes

• A functional discount ğ price reduction offered by the seller to the trade channel members if they perform certain functions such as selling, storing and record-keeping

• A seasonal discount ğ price reduction to buyers who buy merchandise or services out of season

• Allowances ğ other types of reductions from the list price (trade-in-allowances, promotional allowances)

Discount and Allowance Pricing

Price Adjustment Strategies (cont.)

• Customer-segment pricing ğ different customer groups are charged different prices for the same product

• Product-form pricing ğ different versions of the product are priced differently but not accoding to differences in their costs

• Location pricing ğ the same product is priced differently at different locations, even though the cost of offering at each location is the same

• Time pricing ğ prices are varied by season, day or hour

• Segmented (Discriminatory) Pricing ğ when a company sells a product or service at two or more prices that do not reflect a proportional difference in costs

Price Adjustment Strategies (cont.)

• Especially effective with ego-sensitive products • (such as perfume and expensive cars)

• Relationship between price and quality perceptions• when alternative information about true quality is available ğ

price becomes a less significant indicator of quality• when this information is not available ğ price acts as a quality

signal• “Reference prices” ğ prices that buyers carry in their

minds and refer to when looking at a given product• Setting prices ending with odd numbers (e.g.19.9YTL)

• Psychological Pricing ğ psychology of prices are considered in addition to their economics

Price Adjustment Strategies (cont.)

• Several forms of promotional pricing:• Loss leader pricing• Special-event pricing• Cash rebates• Low-interest financing• Longer warranties• Free maintenance and service contracts• Discounts from normal prices

• Promotional Pricing ğ temporarily pricing products below the list price and sometimes even below the cost, to increase short-term sales

Price Adjustment Strategies (cont.)

• Important issues:• Whether the company should charge higher prices to

distant customers to cover the higher shipping costs and risk losing their business

• Whether it should charge a lower price hoping that a lower price will generate a higher sales volume

• How to get paid?

• Geographical Pricing ğ involves the company deciding how to price its products to different customers in different parts of the country.

Price Adjustment Strategies (cont.)

• The price to be set in a specific country depends on:• Economic conditions• Competitive situation• Laws and regulations• Development of the retailing and wholesaling system• Specific consumer perceptions and preferences• Marketing objectives of the company

• International Pricing ğ involves companies in deciding what prices to charge in different international countries in which they market

Price Changes

• Price Cuts – situations leading a firm to consider price cutting:• Excess capacity• Declining market share• To dominate the market through lower costs

• Price Increases• Cost inflation• Overdemand

Price Changes (cont.)

• Buyers’ Reactions to Price Cuts:• Current models are being replaced by newer models• Current models have some fault and are not selling

well• The firm is in financial trouble and may not stay in

business• Price will come down even further• Quality has been reduced

• Buyers’ Reactions to Price Increases:• The item is in demand and will be unobtainable

unless it is purchased soon• The item represents an unusually good value

Price Changes (cont.)

• Competitors are most likely to react when:• the number of the firms in the industry is small• the product is homogenous• the buyers are higly informed

• Competitors’ Reactions on a price cut:• the company is trying to obtain a larger market share• the company is dooing poorly and trying to increase

its sales• the company wants the whole industry to reduce

prices to increase total demand

Price Changes (cont.):

Responding to Price Changes

Price Changes (cont.)

• Responses to Competitors’ Price Cuts:• Reduce the price to match competitor’s

price• Maintain the company’s price but raise the

perceived quality of its offer• Improve quality and increase price• Launch a new low-price fighting brand